Looking at turnover, margins, and dollar contribution
If the title of this article were to indicate that we were going to discuss financial ratios, most readers would quickly turn to another page. Whether we are discussing gross margin return on investment, asset turnover ratio, or any number of statistics that we can calculate utilizing a financial sheet, the majority of retailers demonstrate little interest for this information.
Many retailers will state the lack of interest in this information is due to complexity of the calculations. Others will report a feeling of hopelessness. They will see an index or percentage calculated for their business, and then compare their store to the national average or the suggested "financially safe" category. They find their store to be rated in a "poor" or "needs serious attention" category, and as they work with the numbers, they see that the changes necessary to obtain a "satisfactory" rating to be beyond their financial or manpower abilities.
Then there is also the retailer who states the only number they are interested in is the balance in their checking account. As a fourth generation retailer, let me persuade you to consider taking a couple of numbers from your financial sheets and using them to make a few extra bucks. I promise the results will be there. Grab your pencil and financial sheets, and within a couple of minutes we are going to put you in a position to make decisions that will fatten your wallet.
We are going to use an example store of Ed's Hobby Shop. As we look at Ed's profit and loss statement (also called the income statement) for a 12-month period, there is a line entitled "cost of goods sold". It tells us how much the inventory cost Ed. For these twelve months, that figure is $185,000. Taking Ed's balance sheet, we quickly calculate that the average inventory for Ed's Hobby Shop for the same 12 month time period was $58,500. To determine Ed's inventory turn, we divide the $185,000 by the $58,500, and get an answer of 3.16 turns.
So, what does this tell you? And more importantly, can we make money with this information? The answer to the first question is, Ed is restocking his store 3.16 times per year. Taking an example of buying a model for $22, and selling it for $39.99, Bill makes a gross profit of $17.99. This situation is repeated 3.16 times per year. The model provides a dollar contribution of $56.85 (3.16 times $17.99) for the year. First examination would say that every merchant could have more profit by either increasing the number of turns, or by increasing the price. We do not know if the price of $39.99 is all that the market will bear, but folks in the grocery business have a turn that is often in excess of 20. Let's help Ed make more money by looking at ways to increase his turn.
The first possibility is to decrease his "quantity on hand". In addition to increasing the turnover, this move will allow Ed to invest the same dollars in other items that he can offer his customers. This idea may work if Ed has several of this same model on the shelf. The key is for Ed to make sure that there is always one of the model when the potential customer comes in the door.
The second way of increasing Ed's turns (and profit) is to increase sales. To increase the sales of our example model, Ed can advertise the model, display it in a more prominent location within his store, or lower the price from the current $39.99. The advertising will call for additional expenses while the more prominent display idea will simply involve Ed's time and efforts.
Let's take a more serious look at the idea of lowering the price. Ed gets a 3.16 turn on this model and has a gross profit of $17.99. His markup is 45%, and we have already calculated that the dollar contribution for the model is $56.85 per year. Let's compare this to other items in Ed's store. At the front of his shop, Ed has a rack of candy bars. The best selling candy bar is sold for 69 cents and has a margin of 11%. There is a gross profit of 8 cents per candy bar. Ed buys the candy bars in a box of 48. As Ed has a sizeable shop, he has a high traffic count. Many people buy one or two candy bars to put in their car or in their shirt.
Ed is buying a box of candy bars every week. How much does this candy bar contribute to the profitability of the shop? Do the math and you will find that the candy bar contributes $199.68 to his profitability. The candy bar contributes $3.51 to every $1.00 that the model kit contributes to the profitability. The nontraditional item is making more money for Ed than the item that everyone expects to find in his shop. This same profitability index may be recurring with many other fast moving items within Ed's Hobby Shop.
But what about the decision to increase Ed's profits with the model? What if Ed were to decrease the price to $29.99? His gross profit is now $7.99. If in changing the price Ed finds a substantial increase in the sales of the model kit, we may make more money. However, he must now sell 8 kits per year to do so. And, if he were to increase the price to $49.99, he would still need to sell 2 kits to have made as much profit as he did when he sold the kits for $39.99. The key is to ask if Ed can increase the price and not lose the number of turns. And, will the increased price cause customers to perceive Ed's Hobby Shop as being high priced?
Reviewing this situation, Ed will probably consider moving the kits to another location within the shop, and begin looking for items that turn quickly. These items, prominently displayed, could be the key to fattening the wallet. Of course, no retailer could perform this review on every product that was sold within his or her store. But, it is an important bit of information that leads to extra profits for the retailer.
Now, as compared to many situations, we have had the opportunity to look at numbers from our financial sheets and make decisions that are going to affect us in a positive manner in our wallet. And, isn't that the idea of our business to begin with?